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4 Things That Will Boost Your Financial Health

Jul 26, 2012

There are many investors that have very healthy portfolios. This means that not only have they invested in strong, long term, wealth building mutual funds and other personal finance instruments, but they have also invested keeping certain strong investment guidelines in place.

If you want to be one of these investors, all you need to do is follow these 4 simple guidelines.

Know Your Asset Allocation

Most individuals that come to us for Financial Planning aren't sure what their ideal asset allocation should be. People have heard the thumb rule that your equity exposure should be 100 minus your age, so they follow the thumb rule and put the remaining money into debt.

This is not the right way of doing things.

Your asset allocation should be across the 3 primary asset classes - equity, debt and gold.

The amount that you need to have in equity doesn't depend on your age, but rather on your goal time horizon and your personal risk appetite and tolerance. If you have 10 years left till your financial goal comes around, you can go up to 75% into equity, with 10% and 15% in debt and gold respectively. If you have less than 3 years to go till your goal arrives, try and avoid exposure to equity altogether and go completely into fixed income products. Considering the current interest rate scenario, your debt portfolio could yield strong gains.

Don't Underestimate the Inflation Effect

Inflation is going to greatly increase your cost of living as the years pass. This is a fact. In order to maintain your current standard of living, you are going to spend more money. Everyone is going to experience the effect of inflation. Some people will need to reduce their standard of living. Others who have anticipated and planned their investments to offset inflation, can either maintain their standard of living, or if they have planned very well, can increase their standard of living.

Know which group you would like to be a part of and take the proper financial planning steps immediately.

Use the Power of Compounding to your Advantage

If you take a look at the table below, you'll see very clearly what the power of compounding is.

Consider a small sum of Rs. 100 invested for 5 years yielding 5% per annum. It grows to Rs. 128 at the end of 5 years, with annual compounding. Now consider that it is invested for 20 years, at 5%. It grows to Rs. 265.

Does the rate of interest matter? Certainly, even a small increase in your rate of return or interest will have a large impact on your maturity value. Consider the same Rs. 100 invested for 20 years at 20% per annum. It grows to become Rs. 3,834. That is, it grows more than 38 times, in 20 years, at 20% per annum, compounding annually.

At the End of Year / Rate of Interest p.a.

5%

10%

15%

20%

5 years

128

161

201

249

10 years

163

259

405

619

15 years

208

418

814

1,541

20 years

265

673

1,637

3,834

So when you invest, remember that time in the market is better than timing the market.

Know Your Goal Amounts

A large part of the data gathering process when building a financial plan comprises quantifying our clients' goals such as retirement, child's education, house purchase, car purchases, child's marriage, family vacations and so on.

Let's take retirement as an example:

What does a peaceful retirement mean for you? Does it means monthly household expenses of Rs. 50,000 and annual medical and travel expenses of Rs. 4 lakhs, all being met by your investments? At what age do you want to retire? Is your spouse currently working? Would your spouse and you like to retire at the same time? Would you like to take regular holidays in your golden years? Would you like to take up a hobby, or spend time doing social work? Is it likely that your expenses will go down during your retirement years, or likely that they will go up? Once your planner and you together quantify your goal, by answering the relevant questions, you will know how much money you need to build to achieve each goal, and can start working towards building the corpus for each goal.

The 4 guidelines given above are easy to remember and equally easy to implement. Once you implement them, you will find that you are automatically less swayed by market movements and can invest with a defined purpose i.e. to achieve your financial goals.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

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